Warren Buffett Really Likes Railroads; Should You?

Four years ago Warren Buffett’s Berkshire Hathaway (NYSE:BRKA) purchased one of the largest rail transport companies in the world—Burlington Northern Santa Fe. Since then the shares of Burlington Northern’s competitors have continued to rise. Regardless of higher prices Mr. Buffett still believes that railroads make for compelling investments, as evidenced by comments he made recently on CNBC. Furthermore, the market seems to agree as shares of the major railroad companies are, for the most part, hitting all-time highs.

Here’s why these companies make for such compelling investments.

First, rail transport companies operate as a de facto oligopoly. There are only a handful of railroad companies that operate across North America, and in any given region west these companies usually only face one or two competitors. In some of the more remote regions in Canada and in parts of Mexico companies such as Canadian National (NYSE:CNI) and Kansas City Southern (NYSE:KSU) face no competition: If some company wants to ship goods by rail from parts of northwestern Canada, for instance, it must ship through Canadian National.

Furthermore, these companies have a very wide economic moat. It takes billions of dollars to build out a network of rail track as extensive as those networks owned by companies such as Norfolk Southern (NYSE:NSC) or Union Pacific (NYSE:UNP).

Second, railroad companies have a lot of pricing power. This comes in part from the fact that these companies operate as an oligopoly. While I am not accusing the rail transport industry of price-fixing these companies know that it is in their best interest to keep prices steady and within range of their competitors so as not to start a pricing war.